Where next for rates?

THE Bank of England stunned the City - and millions of British borrowers - by hiking rates earlier this month. So should we be braced for further increases? Ed Monk investigates

ANYONE reassessing their spending habits following last Thursday's rise in interest rates could find themselves doing their sums again soon.

The decision by the Bank of England Monetary Policy Committee to raise the UK base rate by a quarter-point to 4.75% was the first change in tack for a year.

The rise, which had been expected but not quite so soon, was explained by some in the City as a pre-emptive strike to pin back rising inflation. But the Bank of England view in its quarterly inflation report today had commentators spooked again with some predicting another rise before the end of the year.

The Bank is charged by the Government with keeping inflation at 2% over a two-year time horizon. It worried the City by warning that inflation, as measured by the Consumer Prices Index (CPI), could keep rising from the June level of 2.5% but should then ease back.

The CPI figure for June was pushed up by a number of short-term factors. The hot summer helped add to the price of food in shops, due to diminished vegetable harvests, meanwhile energy providers have already pushed up the cost of gas and electricity and will order further hikes if crude oil prices remain high.

Furthermore, announced increases in university tuition fees are expected to add another 0.25% to CPI over the next year, according to economists.

Any interest rate decision will target the longer term given the two-year view that the Bank is told to take. That said, the new forecast from the inflation report still puts CPI above the 2% target in 2008.

Peter Newland, UK economist at investment bank Lehman Brothers, said: 'The Bank's predictions have inflation at about 2.1% in two years time. It has left the door open to another rise. It's not set in stone but if it comes this year it could be in November, before the next inflation report.'

Governor Mervyn King said that the MPC expected inflationary pressures to remain steady in the longer term, despite the higher than usual short-term pressures. Forecasts for economic growth were slightly higher than in the Bank's May report but spending in the High Street was stable and business investment saw a moderate recovery.

Philip Shaw, chief economist for Investec Bank, said: 'It is clear that rates have to rise but not immediately or aggressively. Rises from here will depend on domestic and global pressures but the MPC has indicated there is little spare capacity in the economy. My gut feeling is for a rise before the end of the year.'

The futures markets, effectively the best measure of all experts' views, shows consumers should be braced for a thrifty Christmas - traders are pricing in two more hikes around the turn of the year.

Factors that affect the MPC decision...

The Bank of England uses interest rate changes to control inflation but considers a range of other facts when it makes its decision.

Economic growth – The economy is running along at a healthy pace. Increasing Gross Domestic Product is expected to push inflation higher and will increase pressure to raise rates. GDP grew 0.7% in the first quarter of this year and 0.7% in the second.

Unemployment – The Monetary Policy Committee takes into account the number of people out of work. Jobless figures have been rising in recent months, easing pressure for rate hikes. The latest Office of National Statistics numbers show that 74.6% of people eligible to work have jobs. The number of people claiming Job Seeker's Allowance has risen while the number of job vacancies has fallen.

The property market – Economists, lenders and homeowners alike have been surprised by a bounce back in house prices this year. There appears to be little sign of a slowdown. The monthly Halifax house price index shows prices edged up 0.2% in July - 8.8% higher than a year earlier. Meanwhile, lender Nationwide showed a July price surge lifted house prices 5.9% over the year - a rate not seen since April 2005. The buoyant market puts pressure on the Bank to raise rates.